Archive for the ‘Foreign taxes’ Category

For roughly 24 hours we dangled – no, fell – off the dreaded “Fiscal Cliff.” Then Congress saved us. Well, saved us from uncertainty at any rate.

While Cliff coverage focused primarily on individual tax rates, two very important tax provisions for multinational firms were extended for another year.

First, the “active financing exception,” which allows domestic corporations to exclude foreign interest income earned by their active foreign subsidiaries was, again, extended until 2014. This rule was created in 1997 as a temporary measure to help U.S. banks and manufacturers compete internationally. It has been annually renewed every year since. We examined it here a few months ago. So Morgan Stanley, Ford, and GE can rest easy for another twelve months.

Second, Congress also extended the “look-through” treatment of certain payments between related foreign subsidiaries (known as “controlled foreign corporations” or “CFCs”) for one more year. With this rule, passive income (namely dividends, interest, rents, and royalties) received by one CFC from a related CFC will not be subject to the Subpart F rules. The Subpart F regime would otherwise force the CFCs’ common U.S. parent to recognize a taxable dividend on such inter-company income. The key to this exemption is that the character of the income in the hands of the payor CFC must not be Subpart F income itself. In other words, once one foreign sub earns foreign income from an active trade or business, the multinational family is free to move it around with no U.S. tax consequences.

In the best plain English I can manage, here is how the epicurean structure works:

Step One (the ingredients): A US firm with valuable intellectual property creates two Irish subsidiaries and one in the Netherlands.

The first subsidiary (“HoldCo”) will be formed in Ireland but actually controlled in a low-tax environment such as Bermuda. While US tax law (which looks to the jurisdiction of incorporation) will consider HoldCo an Irish subsidiary of the parent, Ireland will consider it a Bermudian entity because that’s where HoldCo’s “effective centre of management” will be domiciled.

The second subsidiary (“DutchCo”) will be a wholly owned subsidiary of HoldCo, organized and controlled in the Netherlands, and will elect to be disregarded from HoldCo, its sole owner for US tax purposes.

The third and final subsidiary, the management company (“MCo”), will be a wholly-owned Irish subsidiary of DutchCo, and will also elect disregarded status. For US tax purposes, all three subsidiaries will be treated as one Irish entity. However, Ireland will view the structure as consisting of three distinct corporations, one subject to Irish corporate tax (MCo) and the others exempt from it (HoldCo and DutchCo).

Step Two (putting it all together): The US parent sells its valuable IP to HoldCo. HoldCo will then license the IP to MCo (through DutchCo). MCo will exploit that IP throughout the world, collecting income. In Google’s case, this income consists of advertising revenue from all its non-US sources.

MCo’s taxable revenues will be reduced by its deductible royalty payments made to DutchCo pursuant to the two subs’ license agreement. Similarly, DutchCo will then pay out its revenues to the Bermuda-based HoldCo. Here are how the taxes then get calculated:

Whatever MCo profits exist will be taxed at Ireland’s 12.5 percent corporate rate. But because it will deduct any royalty payments made to HoldCo, this number will be relatively small. (This, by the way, is the essential condiment of the Irish Sandwich: the fact that it relies on Ireland’s history of relatively weak transfer pricing laws. Transfer pricing rules typically ensure that charges between units of a multinational corporate family approach fair market arm’s-length value. Otherwise, a US firm could easily drain its profits by making wildly expensive (and tax-deductible) payments to its own Bermuda subsidiary. Google’s Double Irish is meant to create the maximum possible tax value for corporations within the relative liberality of Irish transfer pricing laws. A successful sandwich relies on bending, but not breaking, these transfer pricing rules. )

The payments that go to HoldCo (through DutchCo) will avoid Ireland’s 20 percent withholding tax on royalties due to operation of certain EU tax treaties.

The majority of MCo revenues will sit in HoldCo in Bermuda, where the corporate tax rate is essentially zero.

The end result? Only a small Irish tax is paid on the vast majority of Google’s non-US income.

It sounds great, but is it legal? Well, Google reportedly only implemented the structure after obtaining an IRS advance ruling after three years of negotiations. So, yes, as long as Google keeps to its agreement, it can continue to eat this sandwich just so long as the Irish, Dutch, and Bermuda ingredients don’t spoil.

Last week, Brazil published MEDIDA PROVISÓRIA No 584(“Provisional Measure 584/2012”), granting a number of tax incentives for businesses supporting the Rio de Janeiro 2016 Summer Olympic and Paralympic Games.

The measure includes tax breaks for:

Imports of tangible goods and services used and consumed in Olympic-related activities;

IOC activities occurring in Brazil and supporting activities carried out by its related (foreign and Brazil) entities;

The activities undertaken by the Local Organization Committee (“RIO 2016”);

Relief from certain Brazilian social security taxes for individuals who support IOC (and related) activities; and

Relief for the local sales of goods and services related to the Olympic Games.

Tax-minded Olympic fans (surely I’m not the only one) will recognize that last item. A similar exemption in London turned the Olympic Village into the world’s tiniest temporary tax haven for international vendors. To their credit, many such sponsors (like McDonalds, Coca-Cola, GE, and Visa) politely declined the tax breaks this summer.

However, the same “tax vacation” will no doubt boost revenues for small and mid-sized local businesses. Indeed, Brazil is no stranger to coupling tax breaks with international sporting competition. The perks described in Provisional Measure 584/2012 are very similar to those granted to FIFA’s 2013 Soccer Confederations Cup and 2014 World Cup to be hosted in Brazil.

Local firms need not even wait till 2016 to claim the tax breaks. The exemptions will apply to transactions carried out between January 1, 2013, and December 31, 2017.

One question I often hear when explaining FBAR liability is, “Are they really going to come after me?”

It’s not an unreasonable question. Oftentimes, the penalties for FBAR non-compliance can seem very severe, especially when dealing with a foreign client who may have recently become a U.S. taxpayer and unknowingly retained reportable accounts abroad.

This week, the U.S. Attorney’s Office for the Southern District of Florida issued a press release that provides an example of just who “they” are truly “going after.”

The presser announced yesterday’s sentencing of Miami Beach resident Luis A. Quintero for willful failure to file his FBARs. So what was the sentence? Roddy, tell him what he won!

Before anyone panics, lets take a look at what Quintero actually did. Court documents indicate that he formed two offshore corporations, which were then used to open certain Swiss UBS accounts, which housed (and hid) roughly $4 million. Quintero then facilitated multiple transfers to and from the subject accounts. Of course, none of that is necessarily illegal had he disclosed the accounts’ existence and their activities.

Which he didn’t.

The U.S. Attorney’s Office also noted that there was no question that Quintero knew that he was required to file an FBAR for the subject accounts. In fact, Quintero had previously filed FBARs for other Mexican bank accounts to which he was attached. That’s a bad fact if you’re trying to argue that your subsequent failure wasn’t “willful.”

The press release further indicates that the Quintero prosecution was a direct result of UBS’s 2009 agreement to cooperate with U.S. authorities in identifying suspected tax cheats. If you have a U.S. client that is, or was, a Swiss UBS customer in the recent past, you may want to suggest a review of their reportable foreign accounts.

How hard could it be? I’ve got a computer. I can stay up late. Most of my clients rarely insist on face-to-face meetings. So what’s stopping me?

Well, for one thing, I don’t know that my firm would be too keen on inadvertently creating a permanent establishment abroad and subjecting itself to French taxes.

That’s pretty much exactly what just happened to a US company that outfitted an Israeli employee with all the tools necessary to work from home. On July 3, 2012, the Israeli Tax Authority (“ITA”) ruled that an Israeli investment portfolio manager’s home office created a “permanent establishment” in Israel for the US company for whom she worked. Thus, the US company was subject to Israeli taxes on its profits allocable to Israel.

“Permanent Establishment” (or “PE”) is a concept used throughout the world to determine whether a business has a taxable presence within a given sovereign jurisdiction. Essentially, once your PE is established in Country X, you can expect to pay some kind of Country X taxes.

Typically, the factors giving rise to a PE will be described in a relevant tax treaty or, failing that, local law. In this case, featuring an Israeli taxpayer and a US employer, the US-Israel Tax Treaty governed. Accordingly, the ITA applied Article 5 of the treaty to hold that the Israeli employee created a PE for the US company in Israel. The ruling relied primarily on the fact that the employee was subordinate to the head of the US investment team, the US company held all the risk regarding its clients, and that the company provided the Israeli employee with the technological and informational tools required for her work.

It should be noted that the ITA found an Israeli PE even though the US company provided no actual financial services in Israel, all its clients were located outside Israel, and the company did not even market to Israeli clients. Indeed, the decision’s actual fiscal impact was somewhat vague since it did not explicitly state how the company’s profits should be allocated to its Israeli PE. Instead, the ITA indicated that it would initially defer to the US company’s chosen method of allocation, subject to review.

While employing workers abroad has never been easier (from a technological and practical standpoint), employers seeking to accommodate key talent should also keep in mind whether an inadvertent PE might result. Alternatives to direct employment include: hiring the worker as an independent contractor, hiring the worker through the worker’s own loan-out entity, setting up a branch office abroad for the worker, and opening an actual subsidiary company to employ the worker. Each option involves its own costs and benefits that should be considered along with the potential tax exposure.

It’s a tax blogger’s dream. In Entergy Corp. v. Commissioner, The Fifth Circuit just held on June 5 that a US company’s UK windfall tax payment qualifies as a creditable foreign tax and creates a circuit split after the Third Circuit recently held otherwise.

What’s a Windfall Tax?

In 1997 the United Kingdom enacted a windfall tax on the excess profits of certain recently privatized utility companies. The tax was meant to address public backlash against what was perceived as bargain sales of the utilities.

The tax imposed on each of the utilities a 23 percent assessment on the difference between: (1) a company’s “profit-making value” (its average annual per day profit multiplied by nine) and (2) its “flotation value” (the price for which it was acquired).

Here, the US taxpayer who owned a UK subsidiary that operated a privatized utility paid the windfall tax and sought a US income tax credit based on that payment. The IRS disallowed the credit. As the Eighth Circuit noted, the parties “essentially disagreed on whether the Windfall Tax . . . constituted a tax on excess profits, creditable under I.R.C. § 901, or a tax on unrealized value” for which no credit would be allowed.

What this Means – Foreign Tax Credit Defined

In general, regulation 1.901-2(a) allows a credit only for foreign taxes the “predominant character” of which is an income tax in the US sense. To have that character, the tax must: (1) reach only realized income, (2) be imposed on the basis of gross receipts, and (3) target only net income.

Third Circuit/IRS Position

In a previous case, the Third Circuit held that the windfall tax did not meet the second requirement – that it be imposed on gross receipts, or an amount not greater than gross receipts. According to this argument, the windfall tax statute focuses on “profit-making value,” an average profits calculation based on a particular time period, not “gross receipts,” even though gross receipts may impact the tax indirectly.

Fifth Circuit/Taxpayer Position

The Fifth Circuit court rejected the Third Circuit’s approach and, more pointedly, the notion that it must only examine the windfall statute’s text in reaching its conclusion. Instead the panel examined the tax’s history and actual effect of the foreign tax on taxpayers. Noting that “both the design and effect of the windfall tax was to tax an amount that, under US tax principles, may be considered excess profits realized by the vast majority of the windfall tax companies,” the panel ruled that the tax was designed to reach net gain under normal circumstances. In practice, the taxpayer demonstrated that the windfall tax’s application would be based on “either actual income or an imputed value not intended to reach more than actual gross receipts.” Consequently, the tax’s “predominant character” was that of the US income tax and that it was a creditable foreign tax under section 901.

At the moment, it’s unclear whether the split will reach the Supreme Court for final determination. The essence of the clash lies in how an unconventional foreign tax might satisfy the three-prong test for US credit-worthiness. While the issue may not be headline-grabbing like a civil rights or due process dispute, the US tax response to more exotic foreign taxes that are not easily categorized represents a real cost to US-based multinationals (this case involved a credit of $243 million). I would guess we’ll see this up for certiorari sooner than later.

To quickly recap the issue, India attempted to tax the $ 11.2 billion purchase of an Indian subsidiary between two non-Indian parties. Earlier this year, the Indian tax authorities lost this fight in front of India’s Supreme Court. The Indian government responded by enacting legislation retroactively imposing a capital gains tax on merger and acquisition deals conducted overseas where the underlying asset is located in India.

Among others, U.S. Treasury Secretary Timothy Geithner has pressed Indian Finance Minister Pranab Mukherjee for reassurances that US investors will not be subject to Indian taxes on years-old transactions. Mukherjee has attempted to soothe concerns, stating at an April 20 conference that older tax cases would not be reopened. According to Mukherjee, “No case can be reopened which is more than six years old.” He further added that “there is no uncertainty” in Indian tax law for foreign investors and that India would hold transparent, open discussions with those who have concerns about the law.

Right or not, the recent tax fight does not appear to be slowing Indian investment.

“We are seeing lots of outbound US investment in India right now,” says Lisa Sergi, a senior tax director at WTAS. “India remains a strong option for our clients in technology and manufacturing as an area with low costs and a terrific market.”

And as for the potential uncertainty of Indian taxes?

“There are clear laws on the books in India, but in practice, the government will fight and hold out until the client pays something more. But in that way, they are no different than California’s Franchise Tax Board,” says Sergi.

So there you have it: Indian tax uncertainty is no less onerous than our own.

And now, the exciting conclusion! This week, we focus on the most common mistakes and hidden traps incoming foreign nationals encounter when using a drop-off trust as part of their tax strategy.

1. Don’t be a control freak.

The most important thing to remember about drop-off trusts is that you may not retain control over its assets. You are completing a gift to a trust that benefits your descendants. If you retain the right to revoke or amend the trust, the trust corpus will be included in your US taxable estate.

2. Give up the benefits.

Because this is a completed gift to the future, you may not retain a right to possess, dispose, or enjoy any particular trust asset or income stream. This means you may not retain a life interest or annuity payment related to a trust asset. Similarly, a retained “reversionary” interest exceeding five percent of trust assets is disallowed. Even a retained power of appointment that allows you to designate beneficiaries in the future will be treated as an excess benefit that can cause the subject property to be included in your US taxable estate. Likewise, the power to change life insurance beneficiaries with respect to a life insurance policy that is owned by the trust will cause the attendant death benefit to be included.

That said, you may be permitted to retain a discretionary beneficial interest. This means the trustee may allow you to benefit from the trust assets, but you may not possess a right to legally force any such enjoyment. For example, an informal non-written arrangement with a trustee that allows you continued enjoyment of trust assets will defeat the trust’s independent nature and cause inclusion in the taxable estate. Also, if the trustee’s discretion is subject to a standard (i.e. for “support, health care, education, and maintenance”) that can be enforced by the settlor as a beneficiary, this retained right will cause inclusion. If, under applicable local creditors’ rights laws, your creditors can force the trust income to pay your debts, this feature will be treated as a retained right that causes inclusion.

3. Replace the trustee with a subordinate.

You are allowed to retain a right to remove and replace independent trustees. This power is often reserved to you as the designated “Trust Protector.” So long as the trustee is not “related and subordinate” to you, retaining this power will not cause US estate inclusion. Generally speaking, a trustee will be “related and subordinate” if the trustee is a close family member, subordinate employee, or a company owned by you.

A properly planned and structured drop-off trust should allow you to both enjoy trust assets as a discretionary beneficiary and preserve the benefit of removing assets from your future US taxable estate. If you have questions about setting up a drop-off trust, contact me.

I have a few rich friends who love to complain about money. One of them, Joe, has a $2 million mountainside view. But he’ll swear up and down that he doesn’t know how he’s going to heat his pool, that he’s underwater on his investment properties, and that he’s got cash flow “issues.”

When it comes to taxes, Apple Inc. is like Joe, but with enormous market capitalization.

Unlike most publicly-traded multi-nationals, Apple’s financial statements actually report deferred taxes on its foreign income. Even though generally accepted accounting principles would allow Apple to not book US tax expenses on its foreign profits if they were deemed permanently invested overseas, Apple nevertheless volunteers this expense. This allows Apple to publicly claim a worldwide effective tax rate of 24.2 percent.

Of course, Apple doesn’t actually pay that tax unless it repatriates those foreign profits. Which it doesn’t. Nor does it seem likely to do so in the near future.

On a March 19 conference call with investors, Apple CFO Peter Oppenheimer specifically noted that the potential tax consequences of repatriation deter any such domestic investment. According to him, U.S. tax laws provide a “considerable economic disincentive to U.S. companies that might otherwise repatriate the substantial amount of foreign cash that they have.” (Of course it helps that Apple’s domestic revenues are strong enough to invest in its business, and to fund its recently-announced dividend and share repurchase program.)

So why does Apple elect to report a larger effective tax rate than required? Nobody outside the company really knows. It may be that Apple is simply saving some current profits for future lean times. If it later decides to permanently not repatriate those foreign profits, Apple could then reverse the tax expense and report those past profits in that future period. Or Apple could simply be avoiding the negative publicity other multinationals experience their international tax structuring is scrutinized (*cough* GE *cough*).

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